Accounting Recognition of Sales Revenue - Research Proposal Example

Accounting Recognition of Sales Revenue Introduction Sales or revenue generation is the core objective of any entity. Sales are executed using different kinds of delivery systems. Cash sales do not mean that delivery of goods have been given immediately on receiving the consideration in cash. Similarly the sale on credit basis does not imply that delivery is delayed because of delayed payment of sale consideration. But as per laid down accounting principles, transactions do not get completed until goods are delivered as risks and benefits associated with ownership of goods get transferred at the time of delivery only. So far as delivery of goods sold is concerned, it may immediate or delayed as per terms of sales. The issues of accounting recognition of both types of these transactions have been discussed in this essay with due consideration of the GAAP available for such scenarios. The accounting treatments have been considered both from the point of view of US GAAP and IFRS (International Financial Reporting Standards) also known as IAS; and at every stage of the accounting recognition of such sales, the issues have also been considered from the practical approach adopted by a certain corporation. Contents Introduction US GAAP for revenue recognition IFRS in respect of revenue recognition Accounting recognition of sales with immediate delivery Accounting recognition of sales with delayed deliveries References US GAAP for revenue recognition Generally Accepted Accounting Principal (GAAP) with regard to recognition of revenue is covered by FASB Statement of Financial Accounting Concepts No.5. As per paragraph 83 of said SFAC No.51, revenue “recognition involve consideration of two factors, a) being realized and realizable, and b) being earned, with some time one and sometimes the other being the most important consideration”. Both criteria are required to be accomplished before the revenue is recognized. The revenue is treated as realized when cash is received for sale of product; and revenue is termed as realizable when a promise to pay is received and that may be either verbal promise to pay or written in the shape of notes receivable. The second condition is that the revenue must be earned. Revenue is treated as earned when enforceable exchange takes place of considerations. That is to say deliveries of goods have been given and promise to pay has been received. Take the case of credit sales where goods have delivered at the time transaction was entered into. In such a transaction a verbal promise to pay has been created on acceptance of delivery by buyer. Accordingly it can be said that revenue has been earned at the time of occurrence of a verbal promise to pay. Again as per SFAC No.5 before recognition of a transaction four basic criteria namely, the arising of basic element of asset or liability or change in equity through such transaction, measurability, relevance, and reliability, are required to be fulfilled. As stated above on delivery of goods a claim to recovery of consideration (which claim is an asset) has arisen. Sales transaction is measurable when the price of sales is agreed upon between seller and the buyer. The transaction becomes relevant when it can be evaluated in the context financial reporting. We can calculate the value of transaction when quantity of goods sold and the sales price is available, and therefore at the stage of settlement about quantity and price the transaction becomes relevant. The transaction of sales becomes reliable when involve a debtor, that is the buyer. Therefore from the point of US GAAP meeting of these four criteria of sales transaction is also important before there is an accounting recognition of the transaction. IFRS in respect of revenue recognition International Accounting standard 18 lays down the regulations for accounting recognition of transactions involving sales of goods. Looking from criteria provided under IAS 18 “revenue from sales of goods should be recognized when the following conditions have been satisfied: a) The entity has transferred to the buyer the significant risks and rewards of ownership of the goods; b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; c) the amount of revenue can be measurable reliably; d) it is probable that economic benefits associated with the transactions will flow to the entity; and e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.”(Technical Summary IAS 18)2 Sales with immediate delivery Sales with immediate delivery include transactions of sales that are on cash or credit basis. Cash sales can be recognized immediately at the time of transaction as at that time the requirements of revenue recognition as prescribed both under UD GAAP and IAS are fulfilled. The revenue can be stated to have been realized as soon as the consideration of sales is received in cash. At the same time revenue is stated to have earned as the possession of goods is delivery at the time of receiving cash. In case of credit sales where good are delivered immediately, the transaction gets recognized as it complies all the parameters of IAS 18. When delivery takes place the ownership of risk and rewards pertaining to goods are transferred to buyer. The seller does not have any managerial control over the goods after the delivered to buyer. The revenue can be measured as the figure of quantity and rate per unit of goods is available from delivery and promise to pay documents. It becomes probable that economic benefits of transaction will flow to buyer as the buyer has undertaken a promise to pay. Lastly cost related to transactions is easily available from delivery and promise to pay documents. Accordingly under credit sale transaction where delivery has taken place, goods are treated to have been sold and transferred. Delivery plays an important role in sale of goods transaction. On delivery of goods sales transaction gets completed and a claim to realization of consideration arises. It can be said that on delivery of goods a non- written promise to pay accrues as soon as the buyer accepts the delivery and has not paid cash. Therefore revenue is realized when the claim of recovery arose as per non- written promise to pay on acceptance of delivery of goods. Let us look at the revenue recognition policy as adopted by Wal-Mart Stores Inc. Revenue recognition policy of Wal- Mart states that “the company recognizes sales revenue net of sales taxes and estimated sales returns at the time it sells its merchandise to customer, except for a layway transactions” (Annual Return 2008, page 33)3 Here the reference of the policy is to sales those are not layway transaction. Layway transaction implies transaction for which delivery of goods not yet transferred to buyer, but those may be cash and credit sales. Wal- Mart recognizes revenue for non- layway transaction as soon as it sells the merchandize to customer. That is to say as soon as delivery and consideration in cash or a promise to pay (may be oral or written) is exchanged and the transaction is recognized by Wal- Mart at that time. Sales with delayed deliveries In a sales transaction where delivery is made with in an agreed upon period, the quantity of goods to be delivered and the rate per unit of sale price are normally available. Therefore the transaction is measurable reliably; it is also probable that economic benefits will flow to buyer (as either cash or promise to pay is transferred); and there are no other costs in respect of transaction. Accordingly the transaction complies with criteria c), d), and e) of IAS 18 mentioned above in this write- up. But as the delivery of goods has not yet taken place. Therefore the seller has not transferred risks and rewards of ownership to the buyer, and also retains the usual managerial and effective control over the goods. That means criteria a) and b) are not immediately complied with; and those will complied with only on delivery of goods. Hence revenue cannot be recognized immediately in transactions involving delayed deliveries, and that will be recognized when deliveries take place. In respect of delayed delivery sales the accounting policy of Wal- Mart, as stated in annual return referred above, states that “The Company recognizes revenue from layaway transactions when the customers satisfies all payment obligations and takes possession of merchandize.” The policy of Wal- mart is that revenue is recognized not only on delivery of goods to buyer but also when the payment is realized on credit sales. This is an additional precautionary measure. As when goods are sold the promise to pay is undertaken by the customer. The revenue is treated to have realized at that time. But Wal- mart does not consider that as parameter for recognition of sales. The recognition takes place only when promise to pay is converted into cash receipt and the possession of goods is transferred to buyer. In other words Wal- mart treats revenue realized on sales when risks and rewards of ownership are transferred on delivery of goods as well as on actual consideration is realized in cash, though revenue can also be recognized on deliver of goods even if the promise to pay is not converted into cash. Conclusion Recognition of revenue is an important policy matter of an organization. The revenue can be recognized when revenue is realized and earned as per the laid down accounting principles. But companies like Wal-mart are taking further precautions to recognize revenue not only when revenue is not only earned but also when revenue is actually realized and not just realizable. References Read More